MACD
A Trader Favorite

What is it used for? To determine the short term momentum of a stock. By looking at the price changes between two moving averages we can detect when institutions are buying and selling.

We don’t care when Yahoo! message board fanatics announce they’re buying a stock. We only care when the institutions are buying a stock. And they don't announce it.

Moving Average Convergence Divergence was developed in the 1960’s by Dr. Gerald Appel.

This indicator uses three exponential moving averages (EMA). The averages are affectionately known as fast, slow and trigger point. The 12 day EMA is the fast, 26 day EMA is the slow and the 9 day EMA is the trigger.

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The difference between the 12 day and the 26 day is calculated and plotted as the MACD point for the day. When the difference is plotted, it's called the 12-26 line (also known as the fast line). When this line crosses over the 9 day trigger line and the crossover occurs under or over the centerline, you got something. The centerline will be showed in the chart below.

When the fast line (12-26 day) crosses over the slow line (9 day) at or just above the centerline, we have the strongest signal a trend will begin. When the crossover occurs further above the centerline, its confirmation of a continuing trend.

When the slow line crosses over the fast line below centerline you have indication of a downtrend.

Enough babbling. Lets look at some charts and make sense of what I just said.

Check out the middle of June. The 12-26 day (bright red) crosses just crosses over the 9 day. This occurs right above the centerline charted as “0”. This is the strongest indication of an upward trend. And lo and behold, almost a 10 point rise.

Look at mid-July. The fast line (12-26) crosses under the slow line and we have a downtrend. If the crossover took place below the centerline it could signify a longer downtrend.

What’s with the small green bars? That’s the MACD histogram. Think of the two indicators as a dynamic duo. The histogram plots the difference between the 12-26 line and the trigger (9 day).

This helps make crossovers and divergences easier to identify. Actually, it lets you know the strength of a bullish or bearish crossover.

When you have a bullish crossover, the histogram bars should be above the centerline. If it looks like a hill is about to form….consider hitting the buy button. The institutional guys have put so much money into this stock that a price increase is imminent. The MACD is your pressure meter.

Notice how in mid-May we had consolidation. By mid-June not only did we get the crossover, but the histogram started to build. The institutions showed their hand.

Bearish crossover and histogram bars that form below the centerline is a sell. Again, look at the histogram in mid-July.

You can get as detailed as you want with MACD and his trusty companion histogram. You can draw trendlines, analyze divergences and change the number of days used to calculate the this indicator. Personally, I don’t mess with it.

If I tinker with the settings on Monday, that doesn't mean it'll give the same results on Thursday.

Bottom line: If trending is not readily apparent to me, I’ll find a stock that is.

That’s how I roll.

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